Regional Oil & Gas - OPEC Agrees On Bigger-Than-Expected Cut

OPEC+ reaches deal to cut 1.2 million barrels per day (mmbpd) output from Oct’s level.

Of which, 0.8mmbpd to be borne by OPEC with Iran exempted.

Positive surprise as market was expecting < 1mmbpd cut.

O&G stocks to regain lost ground.

Oil rebounds as OPEC+ agrees on bigger-than-expected production cut.

Despite a lot of jockeying around – Trump’s pressure to keep crude prices low, seeming disunity within OPEC, and Russia’s mixed signals - OPEC+ coalition has agreed to cut 1.2mmbpd of supply from Oct’s production level, starting from January. OPEC (Iran exempted) will bear a cut of 800,000 barrels per day (bpd) and non-OPEC will reduce production by 400,000 bpd.

Following the news, Brent prices recovered 2.7% to US$61.67 per barrel (bbl), touching a high of US$63.73 (+6.2%) intraday.

Maintain our recently lowered oil price forecasts.

The outcome was better than downplayed expectations of < 1mmbpd from Saudi’s initial guidance of 1-1.4mmbpd. The cut is expected to offset potential supply growth from the US in 2019.

At end Nov, we had revised down our average Brent crude oil forecast by US$5/bbl for 2019 to US$70-75/bbl (from US$75-80/bbl earlier) and 2020 average Brent crude oil forecast to US$65-70/bbl (from US$70-75/bbl earlier) factoring in the wider than expected supply/demand gap given Iran sanction waivers, weaker global GDP growth expectations, trade wars, and emerging market weakness. We will continue to monitor those developments and review our projections accordingly.

O&G players to breathe a sigh of relief.

The stock prices of upstream players have fallen by 15-30% over the last 2 months on looming concerns of slower demand growth, exacerbated by stronger supply growth from the US as well as Iran’s temporary waiver.

The OPEC deal is a relief to the oil market, and this will likely lift the sentiment on O&G players, in particular, the key upstream proxies - CNOOC, Petrochina, Sinopec, Medco, Hibiscus, PTTEP, and shipyards - Sembcorp Marine (SGX:S51) and Sembcorp Industries (SGX:U96).

What has happened?

On 7 December, the OPEC+ coalition agreed to a larger than expected cut of 1.2mmbpd, with OPEC members to shoulder a reduction of 0.8 mmbpd and non-OPEC parties including Russia to absorb the remaining 0.4 mmbpd. Brent prices initially surged as high as US$63.73/bbl from a low of US$59.14/bbl, but relinquished some gains amid the broader sell-off in the market to close at US$61.67/bbl.

What are the details of the OPEC+ agreement?

OPEC members will reduce production by 0.8mmbpd, with Saudi Arabia accounting for 0.3-0.5mmbpd of the cut.

Surprisingly, the head of OPEC announced explicit plans to slash production to 10.7mmbpd in December, and subsequently to 10.2mmbpd in January, from its peak of around 11.0mmbpd in November, despite the potential of triggering a barrage of tweets from Trump.

Non-OPEC members will reduce production by 0.4mmbpd, with Russia accounting for 0.22-0.23mmbpd.

Iran, Libya and Venezuela are excluded from the cuts, given the US sanctions on Iran and Venezuela, and severe production outages in Libya.

October’s production quantity will be the baseline for output cuts.

Production cuts are set to be effective in January, and will last for 6 months.

Where do oil prices go from here?

We anticipate oil price volatility to persist. The rebound in Brent oil price is expected to extend into the final weeks of 2018 and beyond to around US$70/bbl, underpinned by Saudi Arabia’s strong efforts to expedite the production cut and certain caveats in the OPEC+ agreement.

While certain countries like Russia will take time to roll out production cuts, Saudi Arabia’s proposed production quantity suggests a substantial reduction of around 0.8mmbpd between November and January, which buys valuable time for the coalition to throttle production.

Additionally, excluding Iran and Venezuela from this round of cuts could translate to an even more pronounced reduction in crude supply, given that any production reduction assigned to these countries would merely be symbolic and inconsequential. As such, we expect the 1.2 mmbpd production cut to balance the oil market, should the OPEC+ coalition honour the agreement, as the 1.2mmbpd cut will largely mitigate Energy Information Administration (EIA)’s projected increase in US production of 1.2mmbpd in 2019.

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